DB schemes mull legal action against LDI asset managers

Following the so-called “mini” Budget on September 23, falling government bond prices prompted a series of collateral calls from DB schemes, which some feared would lead to a “doom loop” that would crash the market.

Issues arose specifically around pension funds’ liability-driven investment strategies, designed to protect against falling interest rates. Most schemes had conducted stress tests for a scenario in which there was a 1 per cent rise in long-term gilt yields, but the 4 per cent increase exceeded the contingency plans in place.

The Bank of England announced a £65bn bond-buying programme in September in an attempt to stabilise markets.

It certainly looks likely that claims concerning LDI are set to become a reality

Amy Khodabandehloo and Justin Briggs, Burges Salmon

The collateral calls led, in some cases, to the fire sale of assets by DB schemes, or trustees entering into emergency arrangements to secure funds to enable them to meet these calls. In other cases, hedge ratios were reduced to avoid contracts terminating.

In November, the Work and Pensions Committee was told that around £500bn in assets were “missing” following the crisis, while the Pension Protection Fund warned that the true extent of the turmoil was still unknown.

While regulators and parliament dissect what happened during the market crisis, schemes are also questioning their own processes and the work conducted by their advisers and asset managers.

Gowling WLG head of pensions disputes Ian Gordon told Pensions Expert that “trustees and sponsors may be concerned that their scheme has suffered financial losses as a result of mistakes made by (among others) investment advisers, fiduciary/asset managers and LDI managers, either in the aftermath of the ‘mini’ Budget or in relation to advice and services they provided earlier in 2022 or before”.

He explained that such losses “may have been suffered when positions have been closed out and subsequently retaken at a cost to the scheme, or in the event of the fire sale of assets necessary to meet collateral calls”.

Issues with LDI pooled funds

Burges Salmon associate Amy Khodabandehloo and partner Justin Briggs believe that “some schemes have suffered losses rather than just experienced the effects of dramatic market movements”.

In a blog published on January 3, the lawyers said “it certainly looks likely that claims concerning LDI are set to become a reality”.

They highlighted issues with LDI pooled funds, where the assets of a large group of schemes are invested together. According to BoE governor Andrew Bailey, there are around 175 LDI pooled funds operating in the UK market, in which 1,800 pension schemes invest.

These funds “experienced major challenges when dealing with significant movements in the gilts market and the timing, volume and value of the collateral calls”, Khodabandehloo and Briggs said.

“In some instances, the well-known principle of treating customers fairly may have been the driving force in deciding that all schemes participating in a fund were deleveraged, irrespective of whether each scheme within the fund could meet its individual collateral calls,” they continued.

“For some schemes, TCF will have paid off; for others, being ‘treated fairly’ might actually have resulted in significant and avoidable reductions in funding levels.”

Khodabandehloo and Briggs explained the driver for TCF “in each particular case will need careful scrutiny; for example, as against the ability of the funds in any event to deal with the logistics of meeting collateral calls for different schemes and to different timings”.

They added that trustees and employers with concerns about how their LDI investments performed “ought to take steps now to investigate their positions and determine if and how things could and should have been done differently following the “mini” Budget in September, in respect of TCF and more widely”.

In a blog post published in December, Freshfields Bruckhaus Deringer partner Andrew Murphy and associate Rebecca Webster also alerted to the possibility of claims in this area, noting that these “would be highly fact-specific and challenging given the complexity of the subject matter”.

“However, this may well be an area of interest to the UK’s claimant law firms, who have a track record in combining multiple compensation claims to save time, reduce legal costs and improve the chances of success,” they warned.

First steps for trustees

Where losses have been suffered as result of the recent gilt market volatility, there are a number of areas trustees need to pay attention to in order to conclude if there is an actionable claim, explained Eversheds Sutherland partner Simon Daniel.

“Some schemes may consider that the services provided by their investment consultant and/or the steps taken by their LDI manager (including a fiduciary manager) potentially fell short,” he told Pensions Expert.

Areas to look at include the suitability of the investment, the advice given in relation to market movements in the run-up to September, the speed at which updates were provided and/or instructions sought, and the exercise of any contractual discretions in relation to funds, he continued.

“In such circumstances, trustee boards will need to take legal advice as to how such claims are assessed, raised and addressed with the respondent party.”

Gordon argued that these claims are complex since there “may be potential defences available”.

He also noted that trustees will need advice on the time limits that apply to bringing such claims before they “become time-barred”.

In addition to time limits that apply under the general law, which is normally six years, “it is necessary to bear in mind that contractual arrangements concluded with third parties might provide for a tighter timeframe within which claims needs to be brought before it becomes too late”, he added.